Minimum Wages and Productivity

Originally published at Econospeak

by Peter Dorman

Minimum Wages and Productivity

I had a chuckle reading a report in today’s New York Times that describes a pair of papers on the minimum wage presented at the recently-concluded economics meetings in Chicago, especially the first, an experimental study by John Horton of NYU.  Horton set up an online matching system between employers and workers, where each made wage offers for a variety of tasks that could be performed remotely.  The design allowed him to measure the actual productivity of workers in these tasks if they successfully concluded a deal with the employers.  Then he imposed a minimum wage to see what would happen.  The result was that employers sought out the most productive workers when they had to pay higher wages to everyone.  (They could estimate productivity differences from information on workers’ prior wages.)

There was lots of back and forth in the article about whether this result would generalize to a minimum wage established over all employers within a region rather than just a few (who could better pick and choose), but for me the irony is that this is exactly what proponents of the minimum wage hope it will achieve.  That is, one of the main purposes of setting a floor under wages is to generate incentives for firms to increase productivity.

Note that it is the firm that is expected to do this.  Economists for some reason tend to assume that productivity is essentially a worker attribute, like how tall you are or whether you’re left-handed.  No doubt workers differ greatly according to their potential productivity, but most actual, realized productivity is the result of the way the work is set up—whether the output is of lesser or greater value, how much and what kind of equipment the worker has available to work with, what kinds of skills the work develops and makes use of, and how much opportunity the worker herself has to tinker with the job to make it go better.  These are employer choices.  In a world of low wages employers have less incentive to invest in the productivity of work, so they don’t.

This argument will hardly come as earth-shattering news to development economists and economic historians.  One of the arguments why the industrial revolution first occurred in Europe rather than China, for instance, is that the possibility of emigration prevented European labor from being as abundant as Chinese, with correspondingly higher wage costs.  A major factor in the explosive rise of the US as an industrial power in the nineteenth century was the availability of cheap land, which put an even higher floor under wage rates.  This is not to say that workers had it easy, of course, just that they were significantly less destitute in some regions than others.

If increasing labor productivity is a major social goal—and it should be—then making labor more expensive is a good thing, all else being equal.  The only trick is to see that, in the modern, mechanized interdependent world, it’s the quality of the job that turns the worker’s potential productivity into the real thing.

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